Credit Smoothing

71 Pages Posted: 7 Oct 2019

See all articles by Sean Hundtofte

Sean Hundtofte

Federal Reserve Bank of New York; Yale University, School of Management

Arna Olafsson

Copenhagen Business School

Michaela Pagel

Columbia University - Columbia Business School

Date Written: October 2019


Standard economic theory says that unsecured, high-interest, short-term debt — such as borrowing via credit cards and bank overdraft facilities — helps individuals smooth consumption in the event of transitory income shocks. This paper shows that — on average — individuals do not use such borrowing to smooth consumption when they experience a typical transitory income shock of unemployment. Instead, individuals smooth their credit card debt and overdrafts by adjusting consumption. We first use detailed longitudinal information on debit and credit card transactions, account balances, and credit lines from a financial aggregator in Iceland to document that unemployment does not induce a borrowing response at the individual level. We then replicate this finding in a representative sample of U.S. credit card holders, instrumenting local changes in employment using a Bartik (1991)-style instrument. The absence of a borrowing response occurs even when credit supply is ample and liquidity constraints, captured by credit limits, do not bind. Standard economic models predict a strictly countercyclical demand for credit; in contrast, the demand for credit appears to be procyclical which may deepen business cycle fluctuations.

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Suggested Citation

Hundtofte, C. Sean and Olafsson, Arna and Pagel, Michaela, Credit Smoothing (October 2019). NBER Working Paper No. w26354, Available at SSRN:

C. Sean Hundtofte (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Yale University, School of Management ( email )

New Haven, CT
United States


Arna Olafsson

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000

Michaela Pagel

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

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